Fixing Tax Mistakes: Avoid Penalties & Minimize Interest

We all make mistakes and when it comes to taxes it is all too easy to slip up. Recognizing mistakes and fixing them as quickly as possible is the key to minimizing interest and penalties and getting back on track.

Employer tax mistakes

Unless you are a very small employer (with quarterly employment taxes under $2,500), you must deposit employment taxes (income tax withholding, FICA, FUTA) on a regular schedule (this depends on the size of your payroll).

If you fail to do so, there is a penalty. This penalty is designed to encourage your correcting a delinquent deposit as quickly as possible because it is only two percent if you are one to five days late. But the penalty escalates over time—more than 10 days late and you are looking at a 15 percent penalty.

What to do: Deposit your tardy employment taxes as soon as possible, making this a priority payment over your other payment obligations (e.g., pay the treasury before some vendors) when you are in a cash crunch.

Note: If you use an outside payroll service, you are on the hook even if the mistake is theirs so be sure you are working with a reliable agent. Check to see if the payroll agent passed the IRS’s Assurance Testing System (www.irs.gov).

You also have to timely file employer tax returns. If you make errors on employer tax returns, file a corrected one:

To correct Form 940 for FUTA taxes, file a new Form 940 and check the box to indicate that it is an amended return.

To correct Form 941 for withholding and FICA taxes (the quarterly return) or Form 944 (the annual return), file Form 941X, or Form 944X.

Mistakes on income tax returns

Say that while preparing your 2014 tax return, your accountant notices a mistake on your 2013 return that could have lowered your tax bill. To claim your refund, you must submit an amended return within the limits fixed by law, and use the right form.

Let’s say the error was on your S corporation’s return. The corporation files an amended Form 1120S and checks a special box indicated that it’s an amended return. Then you as the shareholder file an amended Form 1040 to reflect the correction on the corporate return; use Form 1040X to amend your personal return.

But what if the flip side applies and you mistakenly omitted income or made some other error that increases your tax bill? If you are a freelancer who failed to report some income that was included on a Form 1099-MISC, the IRS likely will catch up with you and send a bill. But the sooner you report omitted income, the smaller your interest cost will be. I know that the interest charge today is very low, but it is still an expense you can avoid by prompt action.

Information reporting slipups

Forgot to send 1099s to contractors or failed to issue W-2s on time? Or you didn’t include all the necessary information on the forms you issued? You may be able to avoid penalties for your mistakes by showing reasonable cause, but merely forgetting is not an acceptable excuse.

Good excuse? Maybe you thought you did not have to issue a 1099 because you are dealing with a limited liability company, but you really did have to issue one if there’s only one member in the LLC because this is viewed as a “disregarded entity.”

If you can’t avoid penalties, you are looking at $30 per 1099 if you correct your mistake within 30 days of the original due date. The penalty goes up to $60 per 1099 if you act after 30 days but before August 1. Miss this date and you’re facing a $100 per-1099 penalty.

What to do: Let’s repeat: correct the mistake as soon as you can to minimize any penalties.

Conclusion

If there is a mistake on your return or you fail to comply with tax requirements, in some cases (as mentioned earlier) you may be able to avoid costly penalties by showing that your failure was due to reasonable cause: you didn’t do it on purpose. But the ball is in your court to tell the IRS before it contacts you. Work with a knowledgeable tax pro to make sure you handle any mistakes properly.

Barbara Weltman is an attorney, prolific author with such titles as J.K. Lasser’s Small Business Taxes, J.K. Lasser’s Guide to Self-Employment and Smooth Failing, as well as a trusted professional advocate for small businesses and entrepreneurs. She is also the publisher of Idea of the Day®, and a monthly e-newsletter Big Ideas for Small Business®. She hosts Build Your Business Radio and has been included in the List of 100 Small Business Influencers for three years in a row. Follow her on Twitter @BarbaraWeltman.

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